USA Aluminum Company is considering making a major investment of $150 million ($5 million for land, $45 million for buildings, and $100 million for manufacturing equipment and facilities) to produce a stronger, lighter material, called aluminum lithium, that will make aircraft sturdier and more fuel efficient. Aluminum lithium has been sold commercially as an alternative to composite materials for only a few years. It will likely be the material of choice for the next generation of commercial and military aircraft because it is so much lighter than conventional aluminum alloys. Another advantage of aluminum lithium is that it is cheaper than composites. The firm predicts that aluminum lithium will account for about 5% of the structural weight of the average commercial aircraft within 5 years and 10% within 10 years. The proposed plant, which has
an estimated service life of 12 years, would have a production capacity of about 10 million pounds of aluminum lithium, although domestic consumption of the material is expected to be only 3 million pounds during the first four years, five million for the next three years, and eight million for the remaining plant life. Aluminum lithium costs $15 a pound to produce, and the firm would expect to sell it at $28 a pound. The building, which will be placed in service on July 1 of the first year, will be depreciated according to the 39‐year MACRS real‐ property class. All manufacturing equipment and facilities will be classified as seven‐year MACRS property. At the end of project life, the land will be worth $8 million, the building $30 million, and the equipment $10 million. The firm’s marginal tax rate is 40%, and its capital gains tax rate is 35%.
(a) Determine the net after‐tax cash flows.
(b) Determine the IRR for this investment.
(c) Determine whether the project is acceptable if the firm’s MARR is 15%.